Thursday, April 18, 2024

Jeremy Grantham says Warren Buffett’s favorite corporate tactic facilitates ‘stock manipulation’ and hurts the economy

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Ah stock buybacks, the most politically charged of all corporate manoeuvres. Ask Elizabeth Warren about them and she’ll tell you they’re pure “market manipulation” and should be made illegal. When public companies repurchase their own stock hoping to boost earnings-per-share, what they’re really doing is cannibalizing innovation, the Massachusetts Senator argues. Money that could have been spent investing in new factories, research and development, or hiring new employees, is instead used simply to lift stock prices, enriching wealthy shareholders and insiders at the expense of economic growth.

But Berkshire Hathaway chairman and CEO Warren Buffet is a firm believer in stock buybacks, having used them extensively for decades. And the 92 year-old billionaire didn’t pull his punches when discussing critics of the practice in his annual shareholder letter released in February. 

“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive),” he wrote, arguing stock buybacks “benefit all owners — in every respect.”

But a new buyback critic has emerged — one that Buffett will have a hard time labeling an “economic illiterate.” Jeremy Grantham, the co-founder and chief investment strategist of Grantham, Mayo, & van Otterloo (GMO), said last week that he, too, believes stock buybacks should go the way of the dodo. Grantham argues that the practice helps companies “live in a world of shortage” that benefits their bottom line, instead of the wider economy.

For example, from 2003 through 2012, S&P 500 companies used 54% of their earnings to buy back their own stock and an additional 37% for dividends, leaving a lack of funds for investing in production growth or employees, according to data from the Harvard Business Review.

“Basically our workers have been royally screwed, they’ve not participated in the substantial productivity [growth] since the 1970s, and the main culprit is now completely legal,” Grantham said on a recent episode of the We Study Billionaires podcast. “That is, stockholders bullying management into doing what management always wants to do anyway — live in a world where you control everything and buy your own stock back.”

Up until 1982, buybacks were illegal and seen as a form of market manipulation. Grantham explained that this is because insiders often base their buyback decisions on non-public information. 

“So of course it is facilitating stock manipulation,” he said. “And in my opinion, of course it should be illegal.”

The hedge funder argued that GDP and productivity growth have slowed in the U.S. since the “new fashion” of buybacks began to take hold in the 80s, giving corporate insiders all the wrong incentives, and the economy would be better off if companies were forced to pay dividends instead.

“Then some of the incentive to buy back stock rather than build a new factory disappears, and there will be a little bit more growth in capital expenditure, which has really done badly,” he explained. 

Grantham went on to criticize Buffett specifically for claiming that buybacks are no different than dividends. The Oracle of Omaha believes the practice is simply another way to return value to shareholders, but Grantham said that when a company pays a dividend it distributes its earnings between its most enthusiastic and least enthusiastic shareholders evenly and that’s not the case with stock buybacks.

“You are constantly retiring the least enthusiastic shareholders. And if you think that that does not remorselessly push up the price of stocks then you are…unimaginative. Of course, it does,” he said.

Grantham argued that if CEOs believe buybacks are the same as dividends, and don’t manipulate the market, then they should just pay a dividend instead.

“People say it’s the same as dividends. Well, if that’s the case, whoopie, then pay out a dividend. Then I’m happy and apparently you’re happy, and Warren will have to pay some taxes,” he said, adding in a sarcastic tone “I’m sorry about that.”

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